Partners & partnerships.

Joint Venture of Husband and Wife

A joint venture conducted by a husband and wife generally is treated as a partnership for federal tax purposes. SBWOTA added Sec. 761(f), which allows a "qualified joint venture" to not be treated as a partnership. A qualified joint venture is a joint venture involving the conduct of a trade or business if (1) the only members of the joint venture are a husband and wife, (2) both spouses materially participate in the trade or business, and (3) both spouses elect to not have the joint venture treated as a partnership.

If a joint venture is a qualified joint venture, the spouses divide all items of income, gain, loss, deduction, and credit in accordance with their respective interests in the venture, and each spouse takes into account his or her respective share of these items as a sole proprietor. Both spouses report their items from the qualified joint venture on separate Schedule Cs. The income remains subject to self-employment tax, but the provision would reduce the burden of filing a partnership tax return.

Note: According to the Joint Committee on Taxation, this provision "is not intended to change the determination under present law of whether an entity is a partnership for federal tax purposes." (28)

Partnership Returns: Failure-to-File Penalty

Prior to the enactment of the Mortgage Forgiveness Debt Relief Act of 2007 (MRA), (29) the penalty for failure to file a partnership return was $50 per month, up to a maximum of 5 months. The new law increases the penalty to $85 per month (Sec. 6698(b)(1)) and extends the penalty period from 5 to 12 months. (30) The maximum penalty is $1,020 (12 months x $85) times the number of partners. This provision is effective for returns filed after December 20, 2007.

Caution: Legislation enacted the day before the MRA, the Virginia Tech Victim's Relief Act, (31) increased the dollar amount under Sec. 6698(b)(1) by $1 for returns filed for tax years beginning in 2008. Thus, the per-partner penalty for filing a late or incomplete partnership return will be $86 per partner (for a maximum of 12 months) for tax years beginning in 2008.

Guaranteed Payments

The IRS ruled in Rev. Rul. 2007-40 (32) that a transfer of partnership property in satisfaction of a partnership's obligation to make a guaranteed payment under Sec. 707(c) is a sale or exchange under Sec. 1001. Because the transfer is a sale or exchange, it is not a distribution within the meaning of Sec. 731. Therefore, the nonrecognition rule in Sec. 731(b) does not apply to the transfer, and the partnership realizes a gain on such a transfer equal to the property's FMV at the time of the transfer less the partnership's adjusted basis of the property.

Example: Partnership P purchased Black-acre for $500. Under Sec. 707(c), A, a partner in P, is entitled to a guaranteed payment of $800. Subsequently, when the FMV of Blackacre is $800 and P's adjusted basis in Blackacre is $500, P transfers Blackacre to A in satisfaction of the guaranteed payment to A. P realizes a $300 gain when it transfers Blackacre in satisfaction of its guaranteed payment to A ($800 (the property's FMV)--$500 (the property's adjusted basis)).

Domestic Production Activities Deduction

The American Jobs Creation Act of 2004 (AJCA) (33) created Sec. 199, which allows a deduction based on a taxpayer's qualified domestic production activities. The deduction is limited to the lesser of the allowable percentage times the qualified production activities income or taxable income, but it cannot be more than 50% of the employer's W-2 wages. Under the AJCA version of Sec. 199, the W-2 wages included all wages, regardless of whether they were attributable to the production activities giving rise to the deduction.

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) (34) amended Sec. 199(b)(2) to narrow the definition of W-2 wages. Under the amended Sec. 199(b)(2), for tax years beginning after May 17, 2006, only wages allocable to domestic production gross receipts are taken into account in determining the 50% of W-2 wages limitation amount. This means that wages for employees not involved in the domestic production activity do not count for limitation purposes. Therefore, for tax years beginning after the amendment's effective date (May 17, 2006), taxpayers are required to trace wages related to domestic production activities.

In 2007, the IRS issued guidance that specifies the conditions under which certain partnerships may choose to calculate qualified production activities income (QPAI) and W-2 wages at the entity level. Eligible entities include a Sec. 861 partnership, an eligible widely held passthrough entity, and an eligible small passthrough entity. In addition, if QPAI and W-2 wages are computed at the entity level, they will be passed through to the partners on the Schedule K-1. (35)

Sec. 704(c)

Sec. 704(c) in Assets-Over Partnership Mergers

In Rev. Rul. 2004-43, (36) the Service addressed whether Sec. 704(c)(1)(B) would apply to Sec. 704(c) gain or loss created in an assets-over partnership merger. The IRS ruled that Sec. 704 (c)(1)(B) applied to newly created Sec. 704(c) gain or loss on property contributed by the transferor partner. However, it did not apply to any reverse Sec. 704(c) gain or loss created from a revaluation of property in the continuing partnership. Likewise, for Sec. 737(b) purposes, net precontribution gain would include the newly created Sec. 704(c) gain or loss from the property contributed by the transferor partnership, but not the reverse Sec. 704(c) gain or loss created by the revaluation of assets in the continuing partnership.

The Service received many comments on Rev. Rul. 2004-43 arguing that the revenue ruling was not consistent with the existing regulations. In response, in 2005 the IRS revoked Rev. Rul. 2004-43 and announced it would issue proposed regulations that would implement the revenue ruling's principles. (37) In August 2007, the Service issued the promised proposed regulations. (38) Those regulations provide that, for any property that had been contributed to either the transferor partnership or the transferee partnership before the merger, the seven-year period will not restart for the original Sec. 704(c) gain or loss. However, for newly created Sec. 704(c) gain or loss in property that was contributed by the transferor partnership to the transferee partnership, a new seven-year period begins on the date of the merger. In addition, for purposes of Sec. 737(b), net precontribution gain includes newly created Sec. 704(c) gain or loss in property contributed by the transferor partnership.

(28) Joint Committee on Taxation, Technical Explanation of the "Small Business and Work Opportunity Tax Act of 2007" and Pension Related Provisions Contained in H.R. 2206 as Considered by the House of Representatives on May 24, 2007 (JCX-29-07), May 24, 2007.

(29) Mortgage Forgiveness Debt Relief Act of 2007, P.L. 110-142.

(30) Sec. 6698(a).

(31) Virginia Tech Victim's Relief Act, P.L. 110-141.

(32) Rev. Rul. 2007-40, 2007-25 IRB 1426.

(33) American Jobs Creation Act of 2004, P.L. 108-357.

(34) Tax Increase Prevention and Reconciliation Act of 2005, P.L. 109-222.

(35) Rev. Proc. 200-34, 2007-23 IRB 1345.

(36) Rev. Rul. 2004-43, 2004-1 CB 842.

(37) Notice 2005-15, 2005-1 CB 527.

(38) REG-143397-05.